Are you a UK contractor? Maximise tax-efficiency by using your pension

The sooner and more consistently you save, the better

To build a successful pension plan, you need to start saving early and contribute regularly to your pension pot. Any pause or break in contributions can have a significant impact on your pension planning.

This is largely down to the effect of compounded returns on continuous contributions. The concept is drawn from the understanding that the more capital you have invested, the higher your sterling returns will be when compared to a lower level of capital with the same level of returns. This amount then increases once you take into consideration continuous further investments over time.

If you own a business that is incorporated as a limited company, there are two ways in which you can contribute towards your pension. You can either make personal contributions or you can make contributions through your company.

See also: Pension auto enrolment – does it apply to UK contractors?

Making personal pension contributions as a limited company owner

The maximum you can personally contribute into a pension and receive tax relief is 100% of your salaried income, subject to your annual allowances. This does not include the dividends you take. This means that only the amount of money that you take as an income will be used to calculate your pension tax relief limit.

Should you take a small salary and a large dividend from your company, your pension tax relief will be low. If you exceed your limit, you’ll be subject to tax charges. You can increase your pension contribution by either increasing your salary or contributing to your pension directly from your company as an employer contribution.

Making employer contributions directly from your limited company

Contributions made from your company are not restricted to your salaried income. Your company can invest, as an employer contribution, up to your full annual allowance of £40,000 and potentially more using previous years’ unused allowance via the carry forward method. The carry forward method allows you to make pension contributions in excess of the annual allowance and receive tax relief.

However, before making any such investment, I would recommend that you seek independent advice. This is especially important for high earners earning over £200,000 per annum, as they may have a reduced annual allowance. Depending on your earnings, this can get as low as £10,000. This is why it’s important to maximise your annual pension contributions before your earnings start to restrict your options.

Tax relief for limited company owners

One of the most tax-efficient ways to extract retained earnings from your limited company is through an employer pension contribution. The rationale here is that these contributions are seen as tax-deductible business expenses, which in turn will reduce the company’s Corporation Tax liability. In addition, this also exempts you from any income tax liability.

This means that 100% of the revenue that you earn will go towards your retirement savings completely free of tax. This then grows completely tax-free. This will allow you to cash out up to 25% of your pension pot completely tax-free after the age of 55.

Things to consider before choosing a pension

There are some great pension options available out there. Before deciding on which one to go with, it’s important that you first consider the following:

• Their cost: This will have a drag on your performance.
• Performance: How have they performed in previous market conditions and cycles?
• Asset allocation: Is their blend of asset classes right for you?
• Flexibility: Can they adapt with you and your needs?

For me a pension is like a pot plant. The more attention you pay to it, the better chance it has to grow. Tax laws, particularly around pensions, are complex. It’s a good idea to get an expert to advise you on how best to set up your pension.

If you have any questions about your pension or want to set up a pension plan, our wealth team is ready to assist. Give us a call on +44 (0) 20 7759 7519 or send an email to wealth@sableinternational.com.